January Monthly

It might not feel like a New Year, as the pandemic continues to ravage most countries. On top of the human toll, the economic fallout will continue to depress activity in the first part of 2021.  However, policymakers throughout the G7 provided more stimulus in late 2020 and extended many emergency facilities well into the New Year.  This will help cushion the blow and help facilitate a stronger recovery later in the year.  

The two Senate seats in Georgia being contested on January 5 will shape the contours of the additional stimulus expected to be pursued by the new US administration.  To be financed by a common bond, Europe’s new Recovery Fund may be operational by mid-year.   These fiscal efforts will be pro-cyclical in the sense of providing for stimulus as aggregate demand is already expanding, as opposed to trying to stop a contraction.  

Meanwhile, central bankers look set to look beyond the near-term clouds and toward better days ahead.  Maximum monetary policy easing is at hand, barring a new negative shock.  Central bank meetings will likely be more about interpreting high-frequency data, including virus and vaccine, than about fresh policy initiatives.  After its strategic view, later in 2021, the ECB is expected to tweak its inflation target to be “2%” rather than “close to but below 2%.”  It may also include “owner’s equivalent rent” into its CPI, as the UK did recently, and the US has consistently done. The net effect will be marginally positive for its measure.  That said, the market has begun pricing in rate hikes in many emerging market economies, including Brazil and Colombia, South Africa and Poland, and South Korea, Thailand, India, and China.  

Several political events stand-out.  The first 100-days of a US President’s term often see a flurry of activity, and this time, for obvious reasons, it is doubly true.  Those Senate races will determine the kind of honeymoon Biden enjoys.  The UK local elections in early May include Scotland. The drive for independence draws energy from the Brexit decision, and the Scottish National Party is expected to be given a strong mandate.  Germany’s election in late October is noteworthy.  For the first time since 2005, Germany will have a new Chancellor.  The Christian Democrat Union has not yet settled on a candidate, and Merkel’s first choices are not running.  A center-left government looks like the most likely outcome at this juncture.  

There had been some thought that Japan’s Prime Minister Suga would call elections early next year.  Elections must be held by late October, but after delivering an extra budget and enjoying popular support, some anticipated Suga would seek a proper mandate as soon as reasonable,  and not simply complete Abe’s term.  However, he has fallen out of favor over policy (refusing to cancel the Go-To-Travel initiative proved controversial) and personal choices (apparently violating social distancing protocols).  

Canada need not have an election until October 2023, but Prime Minister Trudeau may call one next year. He leads a minority government, entering its second-year, reliant on the New Democrats to pass key legislation, including the budget.  Perhaps the ideal time, from a realpolitik, would be as the fiscal transfers kick-in, the vaccine rolls out, and the economy gains traction.  Maybe that would be in the middle six-months of the year.  

Investors also seem to be looking beyond the immediate news stream. The reflation trade, anticipating a post-Covid burst of economic activity, seems central to many investment plans.  Businesses are cash-rich. The S&P 500 companies have roughly $2.5 trillion in cash, for example. Some will be distributed to shareholders via share buyback programs and dividends.  

It also looks like a ripe opportunity for more merger and acquisition activity after accelerating in recent months. Distressed divestitures may be part of the story from over-levered businesses or those seriously damaged by the fallout from the virus.  The pandemic may also encourage companies to reevaluate core businesses and ensure supply chains are resilient, which may require redundancies or higher inventories. Interest rates are low, and equity prices are elevated, making for cheap currency for acquisitions to build scale and expand scope.

Medium-sized businesses across various industries also look poised for consolidation, and some activity was stymied by the pandemic.  It is not just corporate investors.  According to one industry report estimated that private equity firms have $3 trillion of “unrealized value” on their books—with carve-outs and strap-on opportunities in the pipeline. 

Tech and pharma led the megadeals in 2020, and activity will likely be strong again this year. Banking consolidation is likely a common theme in the US, Europe, and Japan.  Retail and the hospitality sector, broadly conceived, are likely to have been shocked into consolidation.  The rationalization of the oil sector is not complete.  Media, both mainstream and social, may also be subject to consolidation.  Data is an increasingly valuable resource, and there have been some juggling of corporate assets, and more are expected. 

The US and Europe appear to be taking different approaches to large social media companies.  The US seems somewhat more willing to go down the traditional anti-trust route while Europe seems to be laying down new rules of behavior.  The massive cyberattack on the US elevates cybersecurity to new levels of awareness.   

Although the Biden administration is thought to be a return to the Atlanticism of the traditional political elite, there has been a divergence of interests.  Several issues standout: the Nord Stream 2 pipeline, the new investment agreement with China, digital tax, let alone the more traditional issues like NATO spending, the eurozone’s sizeable current account surplus, and, of course, the generation-old Airbus and Boeing dispute.  

Similarly, the change in administrations in Washington means a new chapter in the confrontation with China.  The sanctions and blacklisting actions are taken in the waning weeks of the Trump administration cut two-ways. They ostensibly give Biden new chits that can be used in negotiations. However, at the same time, they bequeath Biden an escalation of the confrontation that limits his tactical choices.  The Trump administration says that the Phase 1 trade agreement has been successfully implemented.  Most private sector estimates suggested Beijing has fallen well shy.   

China remains integrated into the world of manufactured goods. It is the only major economy that appears to have expanded in 2020.  Foreign demand for medical supplies and electronics during the pandemic lifted China’s trade surplus to record levels.  The early signs suggest that its supply chains are more resilient than many expected.  Surveys of US, Japanese, and Korean businesses, where governments have produced some inducements to leave China, have shown a consistent reluctance to re-shore.  There has been a shift of production capacity in some industries, and Vietnam and Thailand seem to be among the chief beneficiaries. 

The next wave of Chinese integration has begun, that is, its inclusion into the global capital markets.  The leading stock and bond benchmarks include Chinese instruments.  The Trump administration’s insistence that Americans do not invest in Chinese companies with ties to the military has prompted those benchmark issuers and US exchanges to accommodate Washington.  There is room to scale, and it may be more disruptive than tariffs.  

The integration of China into the capital markets is desirable for Beijing, and officials seem to recognize the price. Foreign investors are interested in the total return and given a host of macroeconomic considerations, the yuan should appreciate. The yuan’s share of the Bannockburn World Currency Index is likely to have risen above the euro to be in second place behind the dollar, based on the 2020 growth differentials.  

Beijing has made its reference rate, around which the dollar is allowed to move by 2%, though it hardly moves in a 1% band, more transparent and in line with market developments.  It has tolerated an 8.2% appreciation of the yuan against the dollar in H2 20.  The upward pressure on the yuan encouraged officials to ease restrictions on outflows.  We expect Beijing will continue to tolerate a gradual appreciation of the yuan. This could see the dollar return toward CNY6.20, which, incidentally appears to be in line with where the US Treasury’s new model says is fair value.  

The dollar’s decline accelerated in the final couple of months of 2020, and it begins the new year with a substantial downside momentum. Many of the technical indicators are stretched, and being short, the dollar appears to be a very crowded trade for the trend followers and momentum players.  The dollar can fall further near-term, and a poor employment report on January 8 poses headline risk.  However, much of the bad news has been discounted, and investors and businesses should be prepared for the hedging and investment opportunities that a countertrend dollar rally will offer.  That said, broadly speaking, we expect the US dollar to decline by 4-5% in 2021. with the risks to the downside.  


Dollar: Three dates in the coming weeks stand out.  The January 5 run-off elections in Georgia will decide which party enjoys a majority of Senate, which will, in turn, shape not only fiscal policy but the broader possibility of the new administration.  On January 8, the December employment data will be reported. The risk for the weakest report since last spring as the virus ravages the country.  The jobs data often sets the general tone for much of the other high-frequency data.  The third date is January 20.  It is the inauguration of Biden as the 46th President.  The following 100 days are likely to see a flurry of activity, including rejoining the Paris Accord and nuclear agreement with Iraq. Another fiscal package is expected in the context of the Georgia results.  While unwinding tariffs and other actions against China are not top priorities, early on, Biden may lift the steel and aluminum tariffs that Trump imposed on traditional US allies.   The dollar’s decline in Q4 20 may help flatter corporate earnings, especially in the tech, pharma, and consumer goods sectors.  The Federal Reserve meets on January 27 and is likely to be as much a non-event as FOMC meetings get.   

Euro:  Europe finished 2020 with several successes.  The long-drawn-out negotiations with the UK produced a new trade agreement. Disputes with Poland and Hungary were resolved, and the European Recovery Fund will be launched in 2021 with joint bonds.  It drafted legislation that provides new rules for digital service companies. Although many European officials seem hopeful of a new rapprochement with the US, it took three actions since the election that underscore the underlying divergence of interests.  It imposed levies allowed by the WTO on $4 bln of US goods in the Airbus-Boeing dispute, continued to try to complete the Nord Stream 2 pipeline, and reached a new investment pact with China.  Under its bond-buying operations, the ECB can buy more bonds than the sovereign members will issue (net of redemptions). Still, January is likely to see large issuance, which will include EU bonds for its joint jobs support initiative, SURE. The German Christian Democrats will pick Merkel’s successor as party leader on January 16, who will then run for Chancellor in October against the current SPD finance minister Scholz.   We expect the euro to rise to around $1.30 in 2021.    


(end of December 2020 indicative prices, previous in parentheses)


Spot: $1.2215  ($1.1925) 

Median Bloomberg One-month Forecast $1.2100 ($1.1850) 

One-month forward  $1.2245 ($1.1940)    One-month implied vol  6.8%  (6.2%)    



Yen: The dollar fell by 1% in December against the yen. It was the fourth consecutive monthly decline.  It brought the annual decline to nearly 5%.  The JPY104 area, which previously offered support, now offers resistance. The dollar is grinding gradually lower against the yen, and we look for a test on parity (JPY100) in 2021 for the first time since 2016.  Due to Japanese stocks’ underperformance, many global fund managers are underweight and unprepared for the Nikkei’s rally to 20-year highs. According to weekly MOF data, foreign investors were net sellers of Japanese equities in 2020, though they became buyers in Q4. Some investors can secure a higher return than in the US Treasury market by buying Japanese government paper and hedging the yen. The third supplemental budget (Prime Minister Suga’s first) will help cushion the economy in Q1 21. The Bank of Japan meets on January 21, and it should pass without much fanfare. Japan is expected to expand by 2.0%-2.5% in 2021, at the lower end of the G7 forecasts.  This is still uncertainty over the contribution (or cost) of the Summer Olympics.  


Spot: JPY103.20 (JPY104.30)      

Median Bloomberg One-month Forecast JPY104.00 (JPY104.00)     

One-month forward JPY103.00 (JPY104.25)    One-month implied vol  6.3% (5.8%)  



Sterling:  The last-minute trade agreement with the EU avoids the worst of outcomes, but the disruption caused by the separation and new customs regime will weigh on growth.  The deal is incomplete, especially for services.  Sterling’s roughly 2.25% appreciation in December was largely a function of the weak US dollar environment, and it finished at its best level since May 2018.  Yet, sterling slipped a little more than 0.75% against the euro and was the weakest of the major currencies after the Japanese yen and Canadian dollar.  The Bank of England does not meet until February 4, and while it could act sooner in an emergency, it seems that the bar is high.  It may be too simple to view the May local elections as a referendum on the Johnson government and Brexit, but a decisive victory for the SNP in Scotland will begin the more formal agitation for another referendum for independence. The EU will play a crucial role as an independent Scotland seems economically viable only within the EU. Some members are not keen to support the independence movements within existing members for fear of what it could mean for themselves.  In the context of the weak US dollar environment, we look for the sterling to test the $1.40 area in the new year and see the risk on the upside.  


Spot: $1.3660 ($1.3325)   

Median Bloomberg One-month Forecast $1.3540 ($1.3110) 

One-month forward $1.3670 ($1.3330)   One-month implied vol 9.2% (9.8%)



Canadian Dollar:  The Canadian dollar was the worst-performing major currency in 2020, rising slightly less than 2% against the greenback.  In fact, at the end of November, it was practically flat for the year. Ottawa’s response to the pandemic in monetary and fiscal policy appears to be among the most aggressive.  The payoff may be that Canada is one of the fastest-growing high-income countries in 2021 (~5%-5.5%).  Prime Minister Trudeau may be tempted to call for an early election as the fiscal stimulus kicks-in, and the vaccine is rolled out.  While US-Canadian relations may warm, Trudeau’s push for a digital tax in 2022, if there is no international agreement by mid-2021, does not give the Biden administration much room to maneuver.  We expect the US dollar to fall toward CAD1.22 in the year ahead.  


Spot: CAD1.2730  (CAD 1.3000) 

Median Bloomberg One-month Forecast  CAD1.2800 (CAD1.3195)

One-month forward CAD1.2700  (CAD1.3005)    One-month implied vol  6.9%  (6.5%) 



Australian Dollar:  Nearly half of last year’s 9.5% appreciation of the Australian dollar was recorded last month.  It approached $0.7700 at the end of the year, its best level since April 2018.  Its acceleration is partly a function of the reflation trade and is thought to benefit from more robust world growth and a weaker US dollar, even though Australian growth is expected to be at the lower end of the high-income countries in 2021 (~2.5%-3.0%).  Australia’s alliance with the US has strained Canberra’s relations with Beijing. China absorbs a little more than a third of Australia’s exports, about 22% of GDP.  China is expressing displeasure with Australia by disrupting trade flows on various products, including coal, wine, lumber, barley, iron ore, wheat, lobsters, and copper ore.  Yet, even with the disruption, the two-way trade between Australia and China was larger than Australia’s trade with the next seven largest partners in October put together, including the US and Japan. Trade figures will be closely monitored as the headwind could intensify.  The most important high-frequency economic report will continue to employment data.  We look for the Australian dollar to rise to $0.8000, with upside risks.   


Spot:  $0.7695 ($0.7345)       

Median Bloomberg One-Month Forecast $0.7625 ($0.7205)     

One-month forward  $0.7700 ($0.7340)     One-month implied vol 10.3%  (9.3%)   



Mexican Peso:  Strong worker remittances, record trade surpluses, and portfolio demand lifted the Mexican peso in H2 20 by 14%, the third-best emerging market currency (behind the South African rand and Chilean peso). President AMLO has been reluctant to back strong fiscal stimulus, and the central bank cut interest rates aggressively until inflation threatened the upper end of its 2%-4% target range. Banxico’s board is more evenly split after the retirement/replacement at the end of 2020, and a window of opportunity to cut rates may open up.  The next policy-making meeting is on February 11, two days after the January CPI figures are released.  Legislative elections will be held in early June. Although AMLO enjoys strong support, his MORENA party faces a close fight as the other three main political parties have come together.  They will support a single candidate in 180 of the 300 seats subject to a majority vote (another 200-seats are also distributed based on proportionality).  Before the pandemic struck, the dollar was in the MXN18.50-MXN18.80 area, and we can see it returning in the year ahead.  


Spot: MXN19.9050 (MXN20.18)  

Median Bloomberg One-Month Forecast  MXN19.8850 (MXN20.21)  

One-month forward  MXN19.97 (MXN20.25)     One-month implied vol 15.3% (13.4%)



Chinese Yuan:  China appears to have emerged from the pandemic in fairly good shape.  Not only is it one of the few countries managed to expand in 2020, but it is poised to accelerate sharply, especially in the next couple of quarters (Q4 GDP due January 18 after 2.7% quarter-over-quarter in Q3). Strong industrial output has helped drive up the prices of metals and commodities. Demand for medical supplies and devices and consumer technology products has spurred an export boom. The relatively high yields and inclusion into global benchmarks have encouraged strong portfolio inflows.  The scuttling of the Ant IPO and official tolerance of failures, even among state-owned enterprises, Beijing has given foreign investors pause, even as it tolerated a strengthening yuan. After a difficult H1, the yuan trended higher and finished the year with a nearly 6.7% gain. The low inflation may pose a challenge to the PBOC, which seems to want to begin normalizing monetary policy. It is not just the drop in pork prices that is notable, but at 0.5%, core CPI is the lowest in a decade. We do not anticipate an early thaw in Sino-American relations but expect Beijing will tolerate a further gradual appreciation of the yuan and envision the dollar falling toward CNY6.20.    


Spot: CNY6.5270 (CNY6.5790)

Median Bloomberg One-month Forecast  CNY6.5175 (CNY6.6960) 

One-month forward CNY6.5310  (CNY6.6025)    One-month implied vol  5.8% (5.2%)



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